Tax Concessions Imminent for Landlords
by Frank Burgess, of Polson Higgs

Concessions to the tax depreciation regime are just around the corner, providing some relief for hard hit commercial building owners in Canterbury.

The legislation will cover from 4 September 2010, and as such, damage from that first earthquake will be covered. Draft legislation has been introduced and is expected to be enacted later this month.

The first issue arises where insurance is paid out on the destruction of assets. A sale of the asset is deemed to occur.

If the insurance proceeds exceed the assets tax book value, depreciation will be recovered and treated as taxable income. The draft legislation allows owners to choose for the depreciation recovery income to be deferred. The recovery will effectively become depreciation against the replacement asset - and only taxable when the replacement asset is sold.

Landlords will have until the end of the 2016 income year to replace assets and rollover the depreciation recovery. The rollover relief may be applied to depreciable property that is irreparably damaged.

The draft legislation also addresses the timing of the deemed sale that occurs when an insured asset is written off. At the moment the deemed sale arguably occurs at the date of the event that gave rise to the write-off, in this case the date of the earthquake. The legislation will treat the deemed sale as occurring when the insurance proceeds can be reasonably estimated.

An example of how this would apply:

A building is destroyed in the earthquake on 22 February 2011.

The asset had the following values:
• $5m cost
• $3m book value
• $6m insurance payment received for its replacement
• $6m spent on replacement

In the absence of the amending legislation, the building owner will have depreciation recovered of $2 million, which would be taxable income to them in the 2011 income year.

The draft legislation will, however, allow the owner to roll the depreciation recovered into the replacement asset. If the insurance proceeds can be reasonably estimated on 30 September 2011, the new rule would time the depreciation recovered into the 2012 income year. However, a decision to defer the depreciation recovered can be made, until the building is actually replaced. To do this, the building owner elects to use the rollover relief by advising Inland Revenue in writing that they have qualifying depreciation recovered that they are deferring, pending their reasonable expectation of replacing the asset by the end of the 2015-16 income year.

Once the building has been replaced, in our example for $6 million, the new building will have an adjusted tax value of $4 million ($6 million - $2million depreciation recovered which is ‘rolled over’). An election will need to be filed with Inland Revenue advising that the deferred depreciation recovered income has been rolled into the tax base for the replacement asset. When the replacement asset is sold the difference between the adjusted tax book value and asset cost, in this case $2 million will be clawed back as depreciation recovery income (provided it is sold for at least $6 million).

Also note there is no tax depreciation available on buildings from the 2012 income year. Building owners should therefore make careful consideration of what is building (non depreciable) and fit out (depreciable).

• Frank Burgess is a taxation specialist with chartered accountants and business advisors Polson Higgs and can be contacted at Frank.burgess@ph.co.nz

Disclaimer: This information is intended to highlight recent developments and issues and should not be used as a basis for making decisions. We recommend you seek professional advice from us before taking action on any specific issue.

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